COVID-19 and Restrictive Covenant Agreements: Is a Wave of Enforcement Disputes Coming?

Just a couple months ago, a sub-4% unemployment rate allowed many US employees to take for granted the ability to eye greener pastures and contemplate moves to business competitors for better pay and opportunity.  Open employment positions were everywhere and qualified prospects seemed to be in high demand for most industries.  That seems like a generation ago.  Now, we are facing an employment rate of 15%, or higher.  With so many Coronavirus and pandemic-related variables, we do not yet know what a “new normal” will look like. 

Hopefully, the vast majority of those who are currently unemployed will soon return to their jobs with their former employers.  But what about those who return to different jobs?  Or those who are now being recruited by competitors?  Will companies that laid off employees subject to restrictive covenants still seek to enforce contractual prohibitions?  Will those same companies have the cash flow to litigate against both the former employee and the competitor in an attempt to bar things like soliciting customers or other competitive activities?  At the same time, some employees may be wondering whether the restrictive covenant agreements they signed are enforceable after a layoff, especially one caused by an economic crisis and government-forced shutdowns. 

All of these questions raise important considerations, particularly in New York where restrictions on employment are already judicially scrutinized for consistency with public policy standards.  It will take some time for case law to catch up with the unique circumstances we currently face.  In the meantime, understanding the general principles that govern the enforcement of restrictive covenants can provide useful guidance, help set expectations, and prepare employers and employees for a potential new wave of New York non-compete jurisprudence.

Restrictive Covenants: A General Background 

Restrictive covenant agreements in New York (and the majority of other states) are subject to certain standards of reasonableness.  Any request for injunctive relief seeking enforcement of a covenant will be scrutinized against the slippery concepts of public policy and a balancing of equities.  Thus, judges already have quite a bit of discretion.  The backdrop of a once-in-a-generation healthcare pandemic broadens that power. 

The well-settled law in New York is that a covenant will be enforced if it: (1) is no greater than is required for the protection of a “legitimate interest” of the employer; (2) does not impose an undue hardship on the employee; and (3) is not injurious to the public.  Bdo Seidman v. Hirshberg, 93 N.Y.2d 382, 388 (1999).  Particularly relevant in today’s climate is the fact that employers often expressly provide in their agreements for covenants to survive regardless of whether the employee ultimately voluntarily terminates her employment or is terminated by the employer with or without cause.  Moreover, even without this specific language in a contract, an employee’s involuntary termination without cause does not – at least automatically – invalidate a restrictive covenant, but is a relevant factor to be considered by courts when determining reasonableness.  See Brown & Brown, Inc. v. Johnson, 115 A.D.3d 162, 170 (4th Dep’t 2014)(“[W]e reject defendants’ contention that they are entitled to summary judgment dismissing [the cause of action for breach of the former employee’s restrictive covenant] in its entirety because [the employee] was involuntarily terminated without cause.”).

Flexing their broad equitable muscles, New York courts regularly enforce reasonable restrictive covenants through the issuance of emergency ex parte temporary restraining orders, as well as preliminary (i.e., temporary) and permanent injunctions.  These court orders vary greatly in their scope from case to case.  Generally, a judicially-restricted former employee may not take certain actions, such as soliciting business from former clients/customers with whom she worked during her prior employment.

When making a request for equitable relief (i.e., an injunction prohibiting certain conduct), an employer carries a heavy burden of proof because an injunction is always considered an extraordinary remedy, especially when it comes to restraining a terminated employee.[1]  For example, even before COVID-19 led to the sudden lay-off of millions of American workers, courts were statistically less likely to grant an injunction in the context of an employee who was terminated without cause.  See e.g., Buchanan Capital Markets, LLC v. DeLucca, 144 A.D.3d 508, 508 (1st Dep’t 2016) (“[S]uch covenants are not enforceable if the employer . . . does not demonstrate continued willingness to employ the party covenanting not to compete.”).   

Important Considerations for Employers

As business demands gradually (hopefully, not so gradually) correct to pre-Coronavirus levels, employers will soon begin bringing back employees who they previously laid off or furloughed and otherwise start lifting hiring freezes.  Chances are that many businesses will focus on bringing operations back to normal, not fine-tuning restrictive covenant clauses.  But for employers with outdated, overbroad form restrictive covenant clauses, now may be the best time to level-set.  Even courts in New York that refuse to enforce unreasonable restrictive covenants sometimes modify (or “blue pencil”)[2] the covenants in order to make them enforceable and thus protect employers’ interests to a certain extent.  Whether courts will do so, however, depends upon a multitude of factors, many of which involve consideration of circumstances existing at the time of hire.

For context, it is no secret that employers often draft restrictive covenants as broadly as possible to maximize the protection of their business interests.  In doing so, employers count on employees complying with the covenants without any challenge, perhaps believing (in more recent years) that if an issue arises, a court considering it will scale back the provision to make it reasonable under New York law, rather than strike the restriction altogether.  Blue penciling, however, is not guaranteed. 

For example, in 2018, in the Commercial Part of New York State Supreme Court, Erie County, Justice Timothy Walker refused to modify an overbroad restrictive covenant in the Brown & Brown case (cited above).  Justice Walker conducted a detailed analysis before finding that the covenant was entirely unenforceable against the following facts:

  • The covenant was a standard one and was, in fact, required of every single employee of the employer, from clerical-level to management;
  • The covenant was imposed as a requirement of the employee’s employment, even though it was never referenced in pre-employment discussions; rather, it was presented to her at her first day of work, after she had already left her previous employment;
  • The covenant was  presented in a stack of documents, the employee was never advised that she could refuse the covenant or negotiate it in any way, and the employee was told that she had to sign each of the documents, that day, to begin work;
  • The agreement containing the covenant was never explained to her;
  • The employee was never advised or given the opportunity to seek counsel;
  • The agreement containing the covenant was presented for signature long after the issuance of the seminal decision of BDO Seidman, which made clear that prohibitions on the solicitation of an employee’s entire client base are per se unreasonable.

Justice Walker, in light of all the circumstances, expressly declined the employer’s invitation to partly enforce the covenant.  Affirming the trial court’s decision, the Appellate Division, Fourth Department noted specifically the employer’s dominant bargaining power and “overreaching.”  Brown & Brown, Inc. v. Johnson, 158 A.D.3d 1148 (4th Dep’t 2018).

With those findings and factors in mind, and considering today’s labor market that is strained by a healthcare crisis (and the leverages a buyer’s market may create), what should employers do as they hire or rehire to maximize their chances of enforcement and to protect their strategic business interests?  Some best-practices considerations:

  • Rather than use a form agreement containing the same restrictive covenant for every employee in an organization, tailor restrictive covenant clauses to the circumstances, taking into account the legitimate business purposes of the covenant and the particular employee’s role and responsibilities;
  • Rather than wait until the first day of new employment to propose a covenant, start discussions about an employment agreement’s provisions, including restrictive covenants, as early as possible during the hiring/negotiation process;
  • Rather than bury a restrictive covenant at the bottom of hiring paperwork, draw new employees’ attention to the covenant, especially in any cover letters enclosing proposed employment agreements;
  • Rather than expect employees to agree to a restrictive covenant on-the-spot, allow for questions about and negotiations regarding a covenant’s language; and
  • Rather than use relic restrictive covenants that may have been enforceable sometime in the past, periodically consult with counsel to ensure that the covenants remain enforceable in light of the most recent court decisions.

Predicting any outcome is never certain, but understanding and considering the Brown factors set forth above should help guide an employer’s hiring process from both an HR and enforcement perspective.  This is particularly true today, when judges, well-aware of the economic consequences of continued unemployment, may be especially wary of contractual prohibitions that by their nature keep people from working.

What Employees Should Consider as They Return to the Workforce

An employee thankful to find a job with a new employer may nonetheless find herself on the other end of a cease and desist letter or lawsuit if she is bound by a restrictive covenant and the new employer is a competitor of her old one.  Again, whether the covenant is enforceable will depend upon whether it is reasonable, and whether a clause is unreasonable (including because it places an undue burden on the employee) could mean something different than before as the country recovers from the COVID-19 crisis.  Because of public policy, post-COVID enforceability analyses conducted by courts in New York (a State already considered to be “employee-friendly”) will likely provide employees with even more opportunities to argue unreasonableness and unfairness.

Given the equitable nature of an injunction request, courts will almost surely have new factors to consider as employees terminated as a result of COVID-19 shutdowns begin to find new opportunities.  A shrewd litigator for an employee, for example, could seek to tip the equities against the employer by arguing that various government programs afforded the employer options other than mass terminations, including a PPP loan under the CARES Act, but the employer chose a different course with less risk to the business owners, notwithstanding the adverse impact on the lives of employees.  Businesses trying to enforce covenants against terminated employees could find rehiring practices placed under a microscope: how many former employees were rehired and how did the company choose who to rehire?  Were younger, less compensated people rehired at higher rates than others?  Were there performance-related issues that affected any potential decision to not rehire a particular employee?  Will courts be influenced by media and law journal articles expressing concern that the prevalence and enforcement of non-solicitation covenants is contributing to income inequality?  Have the business interests (i.e., customers, market, and competition) of the company changed?  These factors and many others may prove relevant and seem to be fair game given the state of the world.  In any case, whether equitable relief should be allowed and whether a restrictive covenant is reasonable in the first instance just became more complicated questions.   

The impacts of COVID-19 will likely be wide-ranging and long-lasting in ways that few can now imagine.  As judges continue to deal with the implications of the pandemic, they are likely to weigh the competing interests of employers and employees in the context of restrictive covenants differently.  Knowing that this unprecedented health crisis will add a new level of complexity into enforceability analyses, savvy employers can use this time to try to protect and strengthen their contractual interests.

If you have any questions about restrictive covenant provisions, please contact a member of the HSE Litigation group. 

[1] If a court denies injunctive relief the matter may still proceed to a determination of damages, but in many, if not most, cases, the proceedings (and settlement leverages) hinge on the injunction decision. 

[2] Bdo Seidman, 93 N.Y.2d at 394 (recognizing the judicial power to sever and grant partial enforcement for an overbroad employee restrictive covenant).

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